A Virtuous Circle of Success in Sight

A Commentary by John Lipsky
First Deputy Managing Director of the
International Monetary FundThe Straits Times (Singapore)
September 18, 2006

Two facts stood out as the world's economic and financial authorities and leading market participants convened for the International Monetary Fund (IMF) and World Bank Annual Meetings.

First, the global economy has performed far better over the past few years than conventional wisdom anticipated, though worries are building about whether the current combination of solid global growth and low underlying inflation is sustainable.

Second, the international economy's good performance has been accompanied by an increase in complexity and the emergence of a new set of risks. Together, these create both an opportunity and a need to update the mandate of the IMF, the international organisation responsible for helping to maintain global growth and stability.

For its part, the IMF has already taken the initiative with an internal reform plan that makes this annual meeting one of the most important of the past few decades.

At the heart of the fund's proposal is the recognition that globalisation - including financial globalisation - provides a powerful impetus to economic progress that should be preserved and broadened. But the new potential risks require new forms of mitigation.

The need for change was already clear in the wake of the international financial and economic crises of 1994-95 and 1997-98. IMF-led financial support and economic stabilisation programmes helped to end these crises and to catalyse economic recoveries, although not without some controversy.

At the same time, there was widespread recognition that the global system - including financial institutions and markets, plus monetary policy and supervisory standards - needed greater transparency in order to avoid any repetition of these crises. Also, the increased completeness, timeliness and quality of economic and financial data appeared to be a necessary element for making the transparency effort effective.

The IMF responded to the demands for increased transparency with several initiatives aimed at, among other things, providing thorough assessments of the quality of individual countries' financial systems, budgetary management and economic data. The goal was to lay the basis for targeted improvements in these areas.

These programmes may have not have garnered much public recognition, but together they helped to lay the foundation for the subsequent strengthening of domestic financial markets in many countries and the continuing rapid growth of international capital flows. These developments provided critical—if largely unheralded—support for global expansion.

The 2000-01 slowdown in global growth—and the associated sharp stock market declines—pointed to a new period of economic and financial challenges. Consensus expectations anticipated a mediocre recovery, marked by heightened economic and market volatility.

The subsequent unexpected economic success, including a two-decade high for sustained global growth and a 40-year low in underlying inflation, may have been unexpected, but it did not occur by chance.

Accommodative monetary policies in the developed economies in the wake of the 2000-01 slowdown, combined with subsequent policy-boosted demand growth in the United States, were critical to the global upturn. Also, globalisation permitted emerging market countries to benefit directly through export gains. As a result, the post-2002 economic expansion has been shared universally to an unprecedented degree.

Many emerging market countries took advantage of the recent favourable environment to strengthen their budgetary positions and accumulate international reserves, enhancing their prospects for continued good performance. In fact, the unprecedented levels of reserves in some emerging economies indicates there is still room for yet faster growth in their domestic spending.

Of course, financial markets have reflected this unexpected economic success. In particular, stock prices in major country markets have strengthened, while long-term bond yields have remained low. Prices of emerging market assets in many cases have risen to new records.

Perhaps even more striking, international investors have shown unprecedented interest in holding emerging market securities denominated in the issuer's own currency. Investors' implicit expectations of sustained economic and financial stability in these markets have challenged long-held views about these economies' inherent structural weaknesses.

The new market advances also improved the financing terms available in these economies. If they are sustained, they will provide a new boost to economic progress, making for a 'virtuous circle'.

The immediate challenge is to push towards new policy reforms that will help to provide a new boost to global productivity gains. At the same time, innovative approaches are needed to anticipate and head off potential new threats to global prosperity.

A critical first step is to ensure commitment to a multilateral approach to economic and financial policy issues. Thus, an agreement in Singapore by the fund's 184 member countries to a realignment in voting shares that reflects the new global economic realities will represent a significant advance.

The IMF's new multilateral consultation process provides the opportunity for a uniquely frank and focused dialogue among key countries on developing a consistent approach to defusing the principal threats to stability and prosperity. It is an innovative, flexible and potentially very effective initiative. The fund is giving heightened focus to the analysis it leads of systemic stability issues created by financial globalisation.

At the same time, it is modernising its unique responsibility for individual country reviews—or 'surveillance', in the language of the fund's Articles of Agreement—in order to make the implementation of internationally responsible, market-driven economic policies more effective.

The goal in Singapore during these meetings is straightforward: Lock in a set of practical steps that will sustain the most widely shared, solid and market-led global economic expansion in decades, while boosting confidence that policymakers are coming to grips with the potential challenges to stability.

Contrary to the warnings about the death of multilaterism, embarking on a new 'virtuous circle' of success is a real option in Singapore.